Gold Gets Nervous

Is gold the biggest winner from the Greek bailout? It was certainly on a tear on Tuesday, rising to $1,757 (U.S.) an ounce, up $22 or 1.3 per cent – which glows next to slight gains among U.S. stocks, dips in European stocks, and shrugs in the European bond market.

Gold producers are doing even better. The NYSE Arca Gold BUGS index of global producers is up 2.8 per cent in afternoon trading, marking its biggest one-day gain in nearly a month. Canadian gold producers, in particular, are shining: Barrick Gold Corp. (NYSE:ABX) is up 2.9 per cent and Goldcorp Inc. (NYSE:GG)is up 3 per cent, which is helping to deliver triple-digit gains for the broader S&P/TSX composite index.

Bloomberg News quoted Bayram Dincer, an analyst at LGT Capital Management: “Long-term forward-looking gold investors are not convinced that the steps are big enough to solve the Greek problem. It is a short-term solution.”

Indeed, it’s not the Greek bailout that seems to be driving gold higher, but the widespread view that the bailout simply buys Europe a little time – given that Greek economic deterioration, combined with austerity measures, are likely to drive the country’s debt to GDP ratio well above targets.

The International Monetary Fund has said that under a worst-case scenario, that ratio could rise to 160 per cent by 2020. But Felix Salmon argues that the worst-case scenario actually looks astonishingly optimistic:

Where’s all this economic growth meant to be coming from, in a country suffering from massive wage deflation? And under this pretty upbeat downside scenario, Greece gets nowhere near the required 120 per cent debt-to-GDP level by 2020: instead, it only gets to 159 per cent.

What’s happening is that nobody is prepared to take the plunge into either of the paths that might eventually lead out of this: sustained aid (not loans) to Greece, or departure from the euro, leading eventually to higher competitiveness and faster growth. Both options would be politically catastrophic, which means that they can’t be taken until there is literally no alternative.

Still, gold is pretty much alone in its nervousness right now. The CBOE volatility index, or VIX, was unchanged on Tuesday afternoon, at 17.9 -- near its low band of the past five years and down from a high of 45 in October. The index tends to rise as investors grow nervous.

As well, the yield on the 10-year U.S. Treasury bond rose to 2.067 per cent, up 6.4 basis points, hitting its highest level since the end of November. As yields rise, bond prices fall -- and falling bond prices suggest that investors are feeling pretty comfortable with the global economic backdrop.